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179 IRET Congressional Advisory 1 (2004)

handle is hein.taxfoundation/iretcgadv0176 and id is 1 raw text is: INSTITUTE FOR RESEARCH ON THE ECONOMICS OF TAXATION IRET is a non-profit 501 (c)(3) economic policy research and educational organization devoted to informing the public about policies thait will promote growth and efficient operation of the market economy. August 31, 2004 Advisory No. 179 CONGRESSIONAL BUDGET OFFICE STUDY SHOWS TAX CUTS HELPING ALL, INCLUDING THE MIDDLE CLASS The Congressional Budget Office (CBO) has issued a study1 examining how the 2001, 2002, and 2003 tax cuts2 altered effective federal tax rates on households of various income levels. The CBO's main study was undertaken at the three pieces o' request of the ranking t Democrats on several eief to p Congressional committees (Senate Budget Committee, Senate Finance Committee, House Budget Committee, House Ways and Means Committee, and Joint Economic Committee). CBO's conclusions have been misrepresented in many media accounts. According to a number of news stories, CBO found evidence that the 2001, 2002, and 2003 tax acts have squeezed middle-class taxpayers. Actually, CBO's main finding is that the three pieces of legislation provide tax relief to people at all income levels, including the middle class. The first part of this paper will describe the CBO study's main findings, and explore some noteworthy results the study uncovered that have received little attention in the press. The second part of this paper will examine fundamental problems with the type of distributional analysis CBO was asked to perform. Such analyses are not reliable and are poor guides when setting public policy. I. CBO's Findings on the Impact of the Tax Cuts CBO presents projected tax rates and tax shares for each twenty percent of households (quintiles) in the income distribution under old (2000) tax law through 2014. It also shows tax rates and tax shares for each quintile finding is that the f' legislation proide eople ait all income ig the middle class. the three Acts due to the 2001, 2002, and 2003 tax cuts as they are phased in and - then phased out between 2001 and 2011, and any residual effects through 2014. It displays the differences between the two sets of tax rates and tax shares as the consequence of . the tax reductions. (The CBO's description of the provisions of is excellent, and the graphical depiction of their effective dates is highly intelligible and quite clever.) The rich pay most of the income tax and face the highest tax rates. The CBO study finds, as has much previous research, that federal income tax liabilities rise sharply with income. CBO estimates that, in 2004, the top 1% of the income distribution will pay almost one-third of federal income taxes and the top 10% will pay two-thirds. Meanwhile, the bottom 40% will have negative income taxes, that is, they will receive money from the government through the income tax system.3 Average income tax rates (income taxes as a percent of income) also are highly skewed. CBO estimates that, in 2004, the average income tax rate will rise from -5.7% for the bottom 20% of households (i.e, they get money from the government), to 3.5% for the middle 20% of households, to 14.2% for the top quintile, including 19.7% for the top 1%.4 (CBO uses an expanded e~em S I ee~ a ~gg

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